What Does A Trading Strategy Consist Of?
Now that we know what a trading strategy is based on, we need to know what it consists of. A typical trading strategy or system is based on three key decisions of any given trade: (1) the precise entry point into the market, i.e. at what point the trader decides to open a position. (2) The precise level or levels to take profit, in other words when you close a profitable position. And (3), the precise level or levels to exit, or close, a losing position. Traders base their strategies around these three key decisions, but many fail to formulate a “blueprint” in order to follow them.
Here is a suggested list of five points to follow when designing your own trading system:
- Decide on the trading style you are comfortable with
- Formulate the rules of the systems
- Test the system
- Backtest the system
- Forward test the system
Are you a trend-follower? A contrarian (someone who goes against prevailing trends), an intraday trader (someone who opens and closes position within a single day) or a long-term trader?
Set rules based around the three key decisions. What are the conditions to enter a buy? What are the conditions to sell? What happens when the market moves in the expected direction, and when it moves against you?
Write all of these rules down.
The first step in testing your system is through visual inspection. Scroll back and forth on the price chart to check whether the system is profitable. If so, then you can test more thoroughly with larger amounts of data and on various financial instruments.
For those with programming knowledge, backtesting the system using trading bots can be very handy. The reports that can be generated can reveal information about profit factors, average losses, wins and so forth.
Once you have a clear system with its own set of rules in place, forward test it before investing your money. See how it behaves in a real trading environment by testing with live prices.
One more video remains in our Trading Basics series, and it’s an extremely important lesson for every trader: Risk Management! Until then.
Disclaimer: This written/visual material is comprised of personal opinions and ideas. The content should not be construed as containing any type of investment advice and/or a solicitation for any transactions. It does not imply an obligation to purchase investment services, nor does it guarantee or predict future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability for any loss arising from any investment based on the same.
Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.